In many M&A transactions you will see reference to normalised working capital (“NWC”)– what does this mean?
Whenever a company is sold (assuming it is sold as a going concern), the buyer will want to ensure that there is sufficient working capital in the business as at the date of completion to fund its normal ongoing operations; the last thing they want is to have to inject further cash into the business straight away. Most company sales therefore involve a price adjustment mechanism in relation to working capital.
The mechanism typically works as follows. The parties will agree the NWC for the business, which becomes a target figure to be included in the Sale and Purchase Agreement (“SPA”). There is then a pound for pound increase to the purchase price for the amount by which the actual working capital at the completion date exceeds the target figure, or a corresponding reduction if the actual figure is less than the target.
Whilst this mechanism for adjusting the purchase price is common, especially in Private Equity transactions or with international buyers, it can be problematic to define what constitutes a NWC for the business and there have been many instances of this mechanism becoming a contentious issue. It is essential that the SPA contains sufficient detail as to which items should be included in the calculation of the target NWC and the actual levels in the post completion accounts.
Working capital is usually defined as net current assets (excluding cash) adjusted for any debt-like items such as unpaid corporation tax, loans and hire purchase liabilities. There is no standard formula for how to calculate the NWC and every transaction is unique in this regard, but any calculation must have regard to both timing and content. Typically, in respect of timing, an average of the last 12 months working capital is taken in order to allow for any seasonal fluctuations.
In respect of content, there are many items which are likely to cause issues; for example, the treatment of deferred income, provisions, cash deposits, cash backed guarantees, or non-trade or one-off items. As noted above, the SPA must be clear in respect of both timing and content factors of the calculation and it is important that you seek expert help to avoid falling into any avoidable pitfalls.
At Murray Harcourt we have a great deal of experience in helping our clients successfully negotiate working capital price adjustment mechanisms. If you would like any further information please do not hesitate to contact either Andy Rose or Stuart Jobbins in our Corporate Finance team.